Certain income related to treaty fishing rights-related activity is exempt from income, self-employment and employment taxes.

IRC Section and Treas. Regulation

IRC Section 7873 provides an exemption from the imposition of tax for income derived by a tribal member directly or through a qualified Indian entity, or a qualified Indian entity, from a fishing rights-related activity of the tribe.

Notice 89-34, 1989-1 C.B. 674 provides guidance on IRC Section 7873 (which was added to the Code by Section 3041 of the Technical and Miscellaneous Revenue Act of 1988), which exempts from federal income and employment taxes certain income derived by Indians from the exercise of their recognized tribal fishing rights.

Earl v. Commissioner, 78 TC 1014 (1982) - Cash shares received by a Puyallup Indian, while acting as a crewman on a non-Indian fishing vessel that fished one of the “usual and accustomed” fishing grounds of the Puyallup Tribe, were not exempt from taxation under the Treaty of Medicine Creek of 1854, 10 Stat. 1132. The 1854 treaty did not contain express exemptive language and the General Allotment Act of 1887, 24 Stat. 388, did not provide an exception to the general rule requiring express exemptive language because the income in question was not derived from operations conducted on the taxpayer’s own allocated land.

Warbus v. Commissioner, 110 TC 279 (1998) - A member of the Lummi Nation, a federally recognized Indian tribe, realized taxable income in the year when the Bureau of Indian Affairs (BIA) discharged him of liability for repaying a loan that it had guaranteed and on which he had defaulted. Although the taxpayer had originally used the loan to finance his fishing business related to Lummi treaty fishing rights, the discharge of indebtedness income was not exempt as fishing rights income. Instead, the discharge of indebtedness income was attributable to the freeing of the taxpayer’s assets from obligations to the BIA, not from any activity “directly related” to harvesting, processing, transporting, or selling fish in the exercise of tribal fishing rights. Furthermore, the taxpayer’s income was generated by the BIA’s discharge of his indebtedness and the BIA was not a “qualified Indian entity” engaged in the harvesting, processing, transporting, or selling fish under Code Section 7873(b).

Hall v. Commissioner, TC Memo 1998-336 - The court determined that a portion of the retirement account distributions paid to a member of a federally recognized Indian tribe were not subject to tax because a portion of the distributions constituted income derived from Indian fishing rights-related activity. The contributions made to the taxpayer’s retirement account by the taxpayer’s employer, a tribal fish hatchery, were excludable from his gross income as income derived from an Indian fishing-rights-related activity.

Smith v. Commissioner, T.C. Memo 2011-82 - Income received by taxpayers for services as tribal council members of the Nooksack Indian tribe was exempt from federal income tax under IRC Section 7873 only to the extent that their compensation was attributable to fishing rights-related activities of the tribe.
IRS Technical Advice Memorandum 9747004, 1997 WL 723504 - Settlement payments made to Indian tribal members were “income derived from a fishing rights-related activity” within the meaning of IRC Section 7873 and were excludable from gross income because the payments were intended to approximate the loss of potential fishing income resulting from state-imposed regulation. The settlement payments were substitutes for lost income that would have been derived from the harvesting, processing, and transporting of fish.

Analysis

General Exemption:

Income earned by a member of an Indian tribe having recognized fishing rights from a fishing rights-related activity of the tribe is exempt from both federal income tax and federal self-employment (SECA) tax. The member may earn the income directly or through a qualified Indian entity with respect to the member’s tribe. Similarly, income earned by a qualified Indian entity from a fishing rights-related activity with respect to the tribe’s recognized fishing rights is exempt from federal income tax.

Important: 25 U.S.C. Section 71 extends the exemption to state and local taxes.

Recognized fishing rightsof an Indian tribe are fishing rights secured as of March 17, 1988, by a treaty between such tribe and the United States or an Executive Order or an Act of Congress. (Although the fishing right must have been in existence as of March 17, 1988, it need not have been formally adjudicated or recognized as of that date.)

Fishing rights-related activities, with respect to an Indian tribe, are any activities directly related to harvesting (including aquaculture), processing, or transporting fish harvested in the exercise of a recognized fishing right of such tribe, or selling such fish but only if substantially all such harvesting was performed by members of such tribe.

Qualified Indian entities* must be:

Engaged in a fishing rights-related activity of the tribe,

100% owned by one or more qualified Indian tribes, their members, or the spouses of members,

In the case of an entity which engages in any substantial processing or transporting of fish, 90 percent or more of annual gross receipts is derived from fishing rights-related activities of one or more qualified Indian tribes each of which owns at least 10 percent of equity interests in the entity, and

Substantially all management functions of the entity are performed by members of qualified Indian tribes.

*Note: A qualified Indian entity may be jointly owned by more than one tribe, or members of more than one tribe, if the entity is engaged in fishing rights-related activities of each of the tribes.

If a processor or transporter fails to meet the 90 percent rule, all income from that year is taxable, as are all wages paid to employees during the year.

In this context, transporting means the shipment of fish for profit as a separate commercial activity, and not the mere carrying of fish from waters where they are harvested to the point of sale or processing.

The 90 percent rule only applies to the processing and transporting of fish. If an entity that is 100 percent owned and managed by tribal members engages solely in harvesting and selling fish, then the entity is a qualified Indian entity, regardless of the 90 percent rule. (But allocations between exempt and non-exempt income would be made).

A member of an Indian tribe who receives any distribution with respect to an equity interest in a qualified Indian entity of the tribe treats the distribution as income from a fishing rights-related activity. The distribution is exempt from taxes to the extent the distribution is attributable to income derived by the entity from a fishing rights-related activity of the tribe.

Wages:

Wages paid to a member of an Indian tribe employed by another member of the same tribe, or by a qualified Indian entity for services performed in a fishing rights-related activity of the employee’s tribe are exempt from:

federal income tax withholding,

the employer’s and employee’s share of Social Security and Medicare taxes, and

unemployment tax.

Employees who perform administrative, judicial, and enforcement duties for a qualified Indian entity in a fishing rights-related activity may qualify for the exemption. The exemption only applies to the duties performed that are directly connected to a fishing rights-related activity. Job categories that may qualify include, but are not limited to:

Fishers, processors and transporters,

Hatchery workers,

Environmental and conservation workers,

Fisheries biologists,

Fishing conservation officers,

Analysts, and

Office staff.

Wages are not exempt from tax if paid by an employer who is not a member of the same tribe or is not a qualified Indian entity. Wages are also not exempt if paid to an employee who is not a member of the tribe whose recognized fishing rights are being exercised.

Important: Treaty fishing rights-related income that is exempt from Social Security, Medicare, SECA and unemployment taxes is not considered when computing benefits under those programs.

Allocation Rules:

In the case of an individual tribal member or a qualified Indian entity, only that income “derived” from fishing rights-related activities is exempt from income, social security, and other tax. Both individual tribal members and qualified Indian entities are required to allocate income and expenses among fishing rights-related activities and all other activities.

Any expense (e.g., operating expenses or depreciation) attributable to such exempt income may not be used to offset gross income derived from fishing outside protected waters or any other income.

Allocations between exempt and taxable income is not required if all but a de minimis amount of the income of the individual or entity was derived from fishing rights-related activities.

A qualified Indian entity is entitled to an exemption from tax only with respect to income attributable to harvesting or processing of fish caught in protected waters by tribal members. Expenses and amounts otherwise deductible that are attributable to such exempt income of the entity may not be used to offset any other income of the entity.

Wages paid to tribal members employed by another tribal member or a qualified Indian entity are only exempt from income and employment taxes to the extent the employee’s work was attributable to harvesting, selling, processing, or transporting fish caught in his or her tribe’s treaty waters.

In the case of qualified Indian entities that are jointly owned by members of more than one tribe, wages paid to a tribal member who is an employee (or a distribution made to a shareholder who is a tribal member) will be exempt only to the extent the income was derived from the exercise of fishing rights of the employee’s or owner’s tribe.

The Treasury Department may adopt regulations providing any reasonable method for allocating wages paid to a tribal member employed by another tribal member or by a qualified Indian entity between wages attributable to the employer’s income derived from fishing rights-related activity and wages attributable to other activities. For example, the allocation method could be based on the activities engaged in by each individual employee or on the employee’s pro rata share of the employer’s gross income from fishing rights-related activity. The regulations are expected to address the extent to which income of owners and employees of entities jointly owned by members of more than one tribe is allocable to the exercise of fishing

Examples

Example 1:

Indian Tribe A has a treaty signed prior to March 17, 1988, that grants fishing rights in all waters in State S. Individual V owns and manages 100% of Company F. Individual V is a member of Tribe A. Company F’s sole activity is harvesting fish in Tribe A’s treaty waters. Company F hires Employee W. Employee W is also a member of Tribe A. Company F is a qualified Indian entity. Company F’s income is exempt from income tax. Income derived by Individual V and Employee W are exempt from federal income, self-employment, FICA and unemployment taxes.

Example 2:

Indian Tribe B has a treaty signed prior to March 17, 1988, that grants fishing rights in the territorial waters off State T. Company G is 100% owned and managed by Tribe B and its members. Company G’s sole activity is harvesting fish in Tribe B’s treaty waters. Employees X and Y are members of Tribe B. Employee Z is a member of Tribe C, which doesn’t share the fishing rights in Tribe B’s treaty waters. Company G is a qualified Indian entity. Employees X and Z are fishermen who spend 100% of their time harvesting fish in Tribe B’s treaty waters. Employee Y is a tribal game warden who spends 60% of her time on treaty fishing related duties and 40% of her time on duties related to hunting. Company G’s income is exempt from income tax. Income derived by Employee X is exempt from federal income, FICA and unemployment taxes. Only 60% of Employee Y’s income is exempt from such taxes. The remaining 40% of Employee Y’s wages and 100% of Employee Z’s wages are subject to all regular employment taxes.

Example 3:

Company H is owned by members of Indian Tribe D and Indian Tribe E. Tribes D and E have a treaty signed prior to March 17, 1988, that grants them fishing rights in River U. Company H receives 80% of its gross receipts from processing fish harvested in River U. It receives the remaining 20% from processing fish harvested elsewhere. Because Company H is a processor and less than 90% of its gross receipts are from fishing rights-related activities of Tribes D and E, it is not a qualified Indian entity. Therefore, none of the income earned by Company H is excluded from income tax as fishing rights-related income. In addition, wages paid by Company H to its employees are subject to all regular employment taxes.

Example 4:

Indian Tribes J and K each have a treaty signed prior to March 17, 1988, that grants fishing rights in Lake L and Lake M, respectively. Company N is 100% owned and managed by members of Tribes J and K and harvests fish in Lakes L and M. Individual O is a member of Tribe J and is employed by Company N. Individual O spends 70% of his time fishing Lake L and 30% of his time fishing Lake M. Company N is a qualified Indian entity. Company N’s income is exempt from income tax. Wages paid to Individual O are 70% exempt from federal income, FICA and unemployment taxes. The remaining 30% is subject to all regular employment taxes because Tribe J doesn’t have treaty fishing rights in Lake M.

Retirement Plans and IRAs

Income derived by Indians from the exercise of treaty fishing rights that are otherwise excluded from income are considered compensation for purposes of qualified retirement plan contributions. Contributions to an IRA based on treaty fishing rights-related income may also be made. No IRA deduction is allowed, however.

The Tax Court has held that the deposit of fishing rights-related income into an IRA does not change the character of the funds. As a result, distributions from the IRA were exempt to the extent of the contributions made from the exempt fishing rights-related income. Only the amounts earned on those contributions were subject to tax upon withdrawal.

Earned Income Tax Credit (EITC)

The EITC is calculated based on a person’s earned income. Earned income includes wages, salaries, tips and other employee compensation, but only if the compensation is includible in gross income. Earned income also includes net income from self- employment. Therefore, treaty fishing rights-related income does not qualify when calculating the EITC.

Issue Indicators or Audit Tips

IRC Section 7873 provides exemptions from federal income, self-employment, and employment taxes (income, social security, Medicare, and FUTA taxes). Adjustments to any of these taxes may exist if the exemption is erroneously claimed. This may occur if:

Work is performed by persons who are not members of the tribe that possess treaty fishing rights,

fishing is done outside waters covered by the applicable treaty,

proper allocations are not made between exempt and taxable amounts,

wages are paid by entities that are not qualified Indian entities

If

Request this Information

Tax Issue

Excluding wages earned as an employee

Proof of tribal membership verified by the tribe. This can be verified with a statement from the tribe or a tribal membership enrollment card. This card includes the enrollment number, the signature of the authorizing official, as well as the official seal.

A statement from the employer verifying that it is either an arm of the tribe or that it meets each of the requirements for qualified Indian entities per IRC Section 7873. These requirements are:
a) It is engaged in treaty fishing rights-related activities of the employee’s tribe
b) It is owned 100% by one or more qualified Indian tribes or members of such tribes (or their spouses).
c) Substantially all management functions are performed by members of qualified Indian tribes.
d) If its business is the processing or transporting of fish, at least 90% of its annual gross receipts are derived from fishing rights-related activities of one or more qualified Indian tribes, each of which owns at least 10% of the entity.
e) This document should also state that the employer maintains records to support these requirements.

Verification of the time allocated to fishing versus non-fishing activity. For example, consider a game warden who is responsible for protecting other wildlife and has other duties, as well as patrolling the treaty waters of his tribe. His employer should verify the percentage of time he engages in fishing rights-related activities of his tribe. The employer should also indicate that the employer maintains records to support the allocation.

Reasonable allocation of exempt vs. non-exempt wages.

Wages paid to a tribal member who is an employee of a qualified Indian entity that is jointly owned by members of more than one tribe would be exempt only to the extent the income was derived from the exercise of fishing rights of that employee’s tribe.

Income derived from the exercise of fishing rights guaranteed to another tribe would not be exempt when paid as wages.

Wages are taxable if the 90% test is not met for employees of processors or transporters. This computation is made on an annual basis.

Excluding income from self-employment

Proof of tribal membership verified by the tribe. This can be verified with a statement from the tribe or a tribal membership enrollment card. This card includes the enrollment number, the signature of the authorizing official, as well as the official seal. For fishermen, a tribal fishing license is also necessary.

Evidence that income is from treaty fishing rights-related activities of that individual’s tribe.
a) For fishermen, this could be copies of fishing logs or fish tickets or other documentation indicating that the activity was conducted in that tribe’s protected waters.
b) For transporters, copies of cargo logs/tickets would be acceptable, so long as such records clearly indicate that the transported fish were harvested in the exercise of a recognized fishing right of the tribe.
c) For sellers, copies of purchase logs and receipts are needed that clearly indicate that the sold fish were harvested to a substantial extent, by members of the seller’s tribe.
d) Request information regarding sales of boats, nets, or other assets during the year

Make sure the fishing income and expenses are matched for fishing in tribal waters and non-tribal waters. Fishing activities in non-tribal waters are taxable.

The taxpayer may have included all fishing expenses on a Schedule C while only reporting the non-tribal fishing income. Expenses that can be specifically identified for non-tribal fishing would be 100% deductible provided the expense is allowable by the code.

For common expenses, a reasonable allocation should be made to the non-treaty fishing activity.

All income is taxable if the 90% test is not met for processors or transporters.

Sales of assets are taxable.

Excluding income as a qualified Indian entity, tribally owned business, or from distributions of a qualified Indian entity

1) Verify the entity is a qualified Indian entity. Determine ownership and verify that the requirements of a qualified Indian entity are met. These requirements are:
a) It is engaged in treaty fishing rights-related activities of a qualified Indian tribe
b) It is owned 100% by one or more qualified Indian tribes or members of such tribes (or their spouses).
c) Substantially all management functions are performed by members of qualified Indian tribes.
d) If its business is the processing or transporting of fish, at least 90% of its annual gross receipts are derived from fishing rights-related activities of one or more qualified Indian tribes, each of which owns at least 10% of the entity.
e) Request information regarding sales of boats, nets, or other assets during the year • Make sure the fishing income and expenses are matched for fishing in tribal waters and non-tribal waters. Fishing activities in non-tribal waters are taxable. The taxpayer may have deducted all fishing expenses while only reporting the non-tribal fishing income.

• Expenses that can be specifically identified for non-tribal fishing would be 100% deductible provided the expense is allowable by the code.
• For common expenses, a reasonable allocation should be made to the non-treaty fishing activity.
• All income is taxable if the 90% test is not met for processors or transporters.
• Sales of assets are taxable

Excluding wages for employment tax purposes

1) Verify the employer’s status as a qualified Indian entity. Determine ownership and verify that the requirements of a qualified Indian entity are met. These requirements are:
a) It is engaged in treaty fishing rights-related activities of the employee’s tribe
b) It is owned 100% by one or more qualified Indian tribes or members of such tribes (or their spouses).
c) Substantially all management functions are performed by members of qualified Indian tribes.
d) If its business is the processing or transporting of fish, at least 90% of its annual gross receipts are derived from fishing rights-related activities of one or more qualified Indian tribes, each of which owns at least 10% of the entity.

Verify each employee’s proof of tribal membership. This can be verified with a statement from the tribe and with the tribal membership enrollment card. This card includes the enrollment number, the signature of the authorizing official, as well as the official seal.

Verify time allocated to fishing versus non-fishing activity. This could be done with time cards, contracts, job descriptions, or executive board resolutions, for example.

A letter stating the amount and tax-exempt nature of an employee’s wages may be issued to the employee to be used for various non-tax purposes, such as bank loans. Exempt wages are not included on Form 941, Form 940, or Form W-2.

Reasonable allocation of exempt vs. non-exempt wages. Wages paid to a tribal member who is an employee of a qualified Indian entity that is jointly owned by members of more than one tribe would be exempt only to the extent the income was derived from the exercise of fishing rights of that employee’s tribe.

Income derived from the exercise of fishing rights guaranteed to another tribe would not be exempt when paid as wages.

Wages are taxable if the 90% test is not met for employees of processors or transporters. This computation is made on an annual basis.